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Today's edition of the Saxo Morning Call features the SaxoStrats team discussing the continuing weakness of the US dollar as commodity prices recover ground and in the wake of key US equity indices hitting all-time highs Thursday.

Chinese investors will keep a close eye on developments around Donald Trump's inauguration on Friday. Photo: iStock

By Martin O'Rourke

Among many strands that are worrying investors in the run up to the inauguration of Donald Trump on January 20, the president-elect's foreign policy pivot towards Moscow and intensely confrontational stance towards China lurks as a deeply disturbing seismic-shift in geopolitics.

Trump's been going after China for some time now. If that looked like just a good bit of old-fashioned scapegoating in the US presidential campaign designed to create sweet music with his highly disaffected hinterland, there has, if anything, been a ratcheting up of the rhetoric ever since his victory was confirmed on November 8.

When he fielded that call from Taiwanese president Tsai Ing-wen in December, Beijing offered him a diplomatic path out of the maze by trying to suggest Tsai had lured the president-elect into a trap. Trump not only snubbed the lifeline, he reinforced the point a few days later by questioning the whole One-China approach that has defined US policy since 1979 and then lambasting China for the seizure of a US drone in disputed waters before Christmas.

The tone mirrors Trump's pre-election mantra that China manipulated its currency to help its export sector and stole US manufacturing jobs and has seemingly set Washington on a collision course with Beijing that could emerge as one of the fundamental themes of the next four years. We are, after all, talking about the two biggest economies in the world.

"There are some really unexpected things happening with the Trump administration and there are no doubt a lot more people paying attention to Twitter at 2am in the night," Wei Li says, in reference to Trump's liking for an unguarded tweet or two in the dead of night. "We are operating in a very different environment where markets are reacting and adapting to changes that have not been seen for a good decade or more."

Wei Li says that it is important to put Trump's criticisms under the microscope and see if they stand up to scrutiny. The currency manipulation charge is once such hotspot.

"It's actually quite difficult to say where the Chinese offshore yuan should be trading so labelling it as 'currency manipulation' is quite a statement," she says. "The Chinese yuan devaluation fear started becoming a mainstream rhetoric in the past couple of years but in years prior to that the Chinese yuan had been appreciating."

USDCNH at the end of 2016 came within a whisker of breaking through the key 7.0 handle before concerted efforts including intervention by the People's Bank of China and slowing capital outflows stabilised dragging the pair back to the 6.800 zone.

USDCNH was at 6.8575 at 1341 GMT, January 16, according to SaxoTraderGO.

USDCNH came within a whisker of breaking 7.0 at the end of 2016 and the steady devaluation of the offshore yuan has given Trump fuel for a pernicious campaign

Source: SaxoTraderGO

"The choice in China was seen as one in which you are either dealing with a businessman like trump where the focus is around profit and figures and the alternative of Hillary Clinton, the continuation effectively of the status quo and a more classic and experienced politician," says Chinese-native Wei Li. "There are still a lot of details as to how the relationship will pan out...but if the anti-trade rhetoric were to continue, you could see that hitting growth potential."

"But it's hard to see the rhetoric continuing on the same scale because of the very intricate nature of the global supply chain," says the London-based analyst. "You can't just write off one aspect of the chain and not consider the impact on the rest so there are a lot of nuanced factors at play and it is probably too early to say what the impact will be on the Sino-US trade relationship."

Wei Li: 'If the US walks away from TPP, then this could create an opportunity for China.' Photo: TradingFloor.com

China, says Wei Li, could even benefit from Trump's clear anti-internationalism stance if he sees through his promise to abandon the Trans-Pacific Partnership.

"It's clear that if the US walks away from TPP, then this could create an opportunity for China in the global trade picture if it leaves a gap," she says. "TPP was a deal that included many countries but [not] China so if that deal does not happen in its original scale, then it may not be a bad thing for China in terms of its market share of global trade."

"There has to be more room to go in the reflation trade, which could also provide quite a stimulus to Chinese commodity exports if consumer goods come under demand," she adds. "We track US data and factor in other content through our in-house GPS growth monitor and we were ahead of consensus in 2016 and continue to be for 2017 even though there has been some catch up recently."

The monitor still points to upside growth."

Certainly, the run up in global equities in the last two months that took the Dow Jones Index to within a point of cracking 20,000 seems to indicate that markets are relatively benign about the ongoing Sino-US relationship.

"The way that markets have reacted and investor positioning seems to show that any tailrisk of a political nature is not fully priced in," says Wei Li.

"Investors have found selling volatilities via Vix futures has been profitable because they have seen vols spikes don't last and this has been a good strategy," she adds. ""Markets have already shown they are adept and resilient at handling Brexit, Trump's election and the Italian referendum."

"The nature of geopolitical tail risk is it is hard to predict ahead of when it happens but what we have seen is that risk volatility has not been prolonged."

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